BofAML: Turmoil Ahead for Pound Sterling Against Euro and Dollar

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Pound Sterling has been a middle-of-the-road performer over the course of the past month with little by way of Brexit news to ruffle its feathers.

The relative stability on the domestic political front has aided Sterling with the markets pricing of a Conservative majority remaining unquestioned by latest polls.

A steady flow of decent data releases that confirms the second quarter of 2017 will be a good one for the economy has allowed the currency to break to a fresh 8-month high against the Dollar which has in turn allowed Sterling to enjoy strength against a number of other smaller currencies.

But, how long can this decent run for the currency last though?

Not long, argue analysts at Bank of America Merrill Lynch Global Research who have this week told their clients that they see Sterling undergoing big moves over coming months.

“We like trading Brexit in FX because it is a theme that is not correlated with any other theme. We also believe that GBP can see moves well beyond what other G10 FX currencies can see in the months ahead-as indeed has been the case since the Brexit referendum. Getting the Brexit short-term and long-term market implications right could offer some of the best opportunities in G10 FX this and next year,” say BofAML in a note to clients dated May 18.

“We have been optimistic that the UK and the EU will agree to a Brexit transition and eventually to a reasonable new trade arrangement. However, getting there is not going to be smooth and the negotiations are likely to have a very difficult and slow start, in our view,” say analysts.

It seems to BofAML that the market has already priced a positive scenario and could be disappointed in the months ahead, when the Brexit negotiations actually start.

The implications for the British Pound are notable.

“GBP will end the year lower, in our view, as Brexit negotiations will have a very difficult start. We remain optimistic for the final outcome and will buy the GBP dip, but we do see a dip ahead. We also see high risks of the negotiations temporarily collapsing at some point, triggering market turmoil until the two sides go back to the negotiating table,” say BofAML.

Note that this is by no means an isolated view with other noted analysts arguing a similar picture will play out - one where the Pound dips and then rises in subsequent months.

For instance, Intesa Sanpaolosay the Pound will dip in the one- to three-month timeframe before making a more concerted attempt at recovery.

Bank of America are forecasting the Pound to Dollar exchange rate at 1.25 by mid-2017 ahead of a recovery to 1.27 by the end of the year and a gradual rise to 1.32 by the end of 2018.

However, the profile for the GBP/EUR looks a little different with the expectations for a stronger Euro over coming months capping any notable recovery potentia.

The Pound to Euro exchange rate is forecast at 1.1905 by mid-year ahead of 1.1765 by the end of 2017 and 1.1495 by the end of 2018.

We are hearing from a number of foreign exchange strategists that there is a good risk-reward ratio in buying the Pound at current levels amidst expectations for a rebound in the currency following a poor run against a host of competitors.

The British Pound might have fallen over recent days on the back of doubts of Theresa May's grip of the helm of the Tory party, but any weakness stemming from this story will be short-lived says one analyst.